Execute A Synthetic Long Call – Bullish Strategy

Introduction To Synthetic Long Call

A synthetic long call consists of buying the underlying security while simultaneously buying a put to protect the underlying security against price decreases. In this way, the synthetic position’s risk and reward profile imitates that of a long call, that is, the synthetic position has an unlimited profit potential with a limited loss potential.

Difference between a synthetic long call and a long call

A synthetic long call involves buying the underlying security and an adequate quantity of put option contracts to insure against price declines. The long call however, is just the buying of call options.

Synthetic long call trade requires cash outlay

A synthetic long call trade requires a cash outlay as the trader is has to buy the underlying security and the put option in order to imitate the risk and reward profile of a long call.

Before executing a synthetic long call, the options trader should conduct economic analysis, fundamental analysis and technical analysis. Look out for events, announcements that will cause the price of the underlying security to move up significantly. By performing fundamental analysis, the trader can determine if the price of the underlying security is worth a lot more than what it is currently. Last but not least, analyse the charts for a suitable entry point. Some chart patterns the options trader should look out for are:

The breakeven point is a price point on the horizontal axis that yields a $0 profit or a $0 loss. That means that at this price point, there is neither profit nor loss. The breakeven point can be calculated using the formula below:

Since the risk/reward profile is similar to that of a long call, a synthetic long call has a limited loss potential. A loss is realisable when the exercise(strike) price of the put is greater than or equal to the price of the underlying security.

The synthetic call has has an unlimited profit potential. This means that there is no ceiling to to potential realisable profit. As the price of the underlying security rises, the realisable profit also rises in tandem.

As long as the price of the underlying security is above the breakeven price point, there will be a realisable profit of the synthetic position is exited.

Because every option contract represent 100 shares in the underlying security, only 1 put option contract is to be bought alongside with the buying of 100 shares in the underlying security. Hence, the above ratio is to be adhered to. If a trader buys a 1000 shares in the underlying security and also buys 10 put options, it is also considered a synthetic long call as the risk and reward profile of the synthetic position still imitates that of the long call.

The price of TTT Corp is trading at $40. An options trader buys a December 40 put at a premium of $2, paying $200 for the contract. He also buys 100 shares of TTT corp at $40, forking out $4000 for the shares. When the price of TTT rises to $60 by the expiration date of the put options, the trader makes a profit of :

$6000 – $4000 – $200 = $1800

However, if the price of TTT Corp falls to $20, the trader’s maximum loss is only $200 as the downside was protected by the put options. In this case, there would have been a loss of $2000 on the underlying security but a profit of $2000 on the put option. Hence, the trader’s loss becomes $200, the premium paid for the put option contract.

Long call Vs Synthetic Long Call

Even if the put options in the synthetic expire worthless, a trader can still hold on to the underlying security to profit from any price movements to the upside. However, for a long call, the call becomes worthless due to time decay. Hence, in a synthetic long call, there is a longer time horizon for the trade to perform.